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Management Accounting
MN20019Lecture 11
Revision
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Lecture 1
Introduction to
Management Accounts
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Management vs Financial
Accounting
Nature of Reports
Level of Detail Regulations
Reporting Interval
Time Horizon Range and Quality of Information
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Management Accounting vs.
Financial AccountingFinancial
Accounting
Management Accounting
Legal Requirement Yes No
Users External & Internal Internal
Level of precision True & Fair Meet users needs i.e. As accurate aspossible
Rules GAAP No rules though some establishedtechniques
Reporting Past data Past & present make future decisions
Scope Whole organisation Segments/depts/products or anyrequirement
Frequency Annually As required
Format Stipulated in Cos act
No set format
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Strategic Decision Making Strategy:
An organisations overall plan or policy to achieve
its goals. Key questions: Where do we want to go?
How are we going to get there?
Theory of constraints: Indentify and remove constraints in system E.g. Limited by supply of raw materials or skilled
labour
i.e. bottlenecks
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Cost Classification The arrangement of cost items into logical
groups; by:
Function
e.g. Administration, production, etc
Nature
e.g. Raw materials, wages, etc
Aim of costing:
Determine the cost of producing a product
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Cost Components Production costs
Materials
Labour
Overheads
Non-production costs
Administration Selling
Distribution
Finance
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Lecture 2
Cost Behaviour, Cost
Estimation & CVP
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Total Cost Y = a + bx
Y = dependent variable (e.g. Total cost)
a = Y intercept (e.g. Fixed cost)b = is the slope of the line (e.g. Variable cost
per unit)
x = independent variable
(e.g. Output)
Therefore
TC = FC + (VC/unit * output)
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Cost Estimation
High/low methodUseful in analysis and planning
Determine fixed and variable cost
Use high/low method: 4 stepsSTEP1 - Analyse costs from previous periods - select highest and
lowest activity level and associated costs
STEP2 - Find the change in cost resulting from the change in output
STEP3 - Calculate the VC/unit.
STEP4 - Substitute back into formula of lineAssumption about costs:
Output costs: either fixed, variable or semi-
variable
Variable costs per unit are constant
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Cost Estimation
Least-squares method Mathematical regression line of best fit
Sum of squares of vertical deviations from that line isless than the sum of the squares of the verticaldeviations from any other line that may be drawn.
Y = a + bx
See Drury 7th p602 for example
!
y b x
a n n 2 2( )
!
n xy x y
bn x x
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Break-Even Point Calculation: Break-even: i.e. Contribution = fixed costs
Contribution/unit * Q = fixed costs
Fixed CostsContribution/unit
Breakeven Point (BEP) =
Output (units) Total costs
6,000 44,700
8,000 57,700
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Example:
A company has different output levels, and incurs different total
production costs at each level, as follows:
Required:
a) If the selling price is 8/unit, what is
the BEP (in units)?
b) What is the break-even revenue?
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Contribution to Sales (C/S) Ratio Alternative method to find BEP
i.e. The amount of contribution earned per of sales
A.k.a. The profit-volume (P/V) ratio Used to find break even revenue
Example (continued)
What is the C/S ratio?
What is the break-even revenue?
Fixed Costs
C/S RatioBreak-even Revenue =
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Margin of Safety Degree to which companies are profitable
A loss is made if sales volume is less than
BEP Margin of safety (as %) = budgeted sales
volume break-even sales volume
MoS (%) =
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Budgeted sales volume - B/E sales volume
Budgeted sales volumex 100%
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Required Profit Levels Assess volume for required profit level
The required profit is like an additional fixed cost whichmust be covered before the company breaks even.
Example: using the same data as before
i.e. Fixed costs = 5,700 & contribution = 1.50/unit
Requirement: Whats the sales volume to make a profit of 10,000?
Answer: Volume = (FCs + required profit)/contribution
= (5,700+10,000)/1.50 = 10,467 units
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Lecture3
Limiting Factor Analysis &
Linear Programming
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Limiting Factor/Scarce Resource Companies create production and sales budgets
May be impacted by a limiting factor/scarce resource
A.k.a principal budget factor
Principal budget factors include:
Market demand
Materials
Manpower (labour)
Machine hours
Capital
The plans of the business must be built aroundthis factor.
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Can also be thought of as
restrictors of growth
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Single Constraint If produce more than one product
Find product mix which maximises profit given
this limited factor
i.e. Maximise contribution in following steps:
i) Determine limiting factor by producing to
maximum demand
ii) Rank products by contribution per unit of
limiting factor
iii) Prepare a production plan
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Multiple Constraints Methods discussed earlier (i.e. single
constraint) do not apply when:
More than one limiting factor exists
Products rank differently for these resources
Under these assumptions linear
programming provides solutions; using Graphs (for 2 products)
Computer programs (for more than 2
products) 20
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Shadow Prices Calculated from the graphical method
Relaxing (or constraining) one of the limiting
factors by a small amount. Usually one unit
Recalculate the optimal solution and associated
contribution
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Lecture 4
Income effects ofAbsorption Costing (AC)
and Marginal Costing (MC)
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Cost Cards Cost card can be drawn up for each
job/batch
Absorption Costing or Marginal costing
Profit calculated by:
Mark-up
i.e. % of total costs
Margin
i.e. % of selling price
Job Cost Card
Job XYZ
Direct Materials x
Direct Labour (hrs * /hr) xVariable Overheads (hrs * /hr) x
Prime Cost x
Fixed Overheads x
Total Cost x
Profit x
Selling price of job x
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Predetermined Overhead
Absorption Rates Businesses cost production throughout year
Therefore predetermine (estimate) absorption
rate Pre-determined OAR =
Note: activity levels refers to production activity
not sales
i.e. Activity levels are the long-term average
Production overheads
- Costs required to support the production process
Budgeted overhead
Budgeted activity level
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Absorption into production
At year end:
Due to:
Actual expenditure more/less than budgeted(expenditure variance)
Actual units produced (volume) were more/less
than budgeted (volume variance)
Overheads Actual levels Predetermined
absorbed (eg labour hrs) OAR= *
Overheads Actual levels Predetermined
absorbed (eg labour hrs) OAR= *
Overheads Actual
Absorbed Overheads
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Under and over absorption of
overheads
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Absorption Costing (AC) Principles of AC
Method whereby allproduction costs are
included in the cost of a cost unit i.e. Direct materials and labour, variable and fixed
production overheads
IAS 2 requires an element of fixed production
overheads to be absorbed into product costfor inventory valuation purposes
All production costs are charged to units ofproduction
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Marginal Costing (MC) Some businesses just want to know variable
costs of the units
Consider fixed costs as period costs (i.e. as sunkcosts)
Marginal costing (MC) includes only thevariable cost of a product or a service
i.e. Cost which could be avoided if the unit notproduced
In text book Variable costs = marginal costs
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Marginal Costing (cont.) Cost card:
Cost Card - marginal costing/unit
Direct Materials x
Direct Labour x
Variable Overhead x
Marginal Cost xFixed Overheads x
Full Production Cost x
Used to value
inventory
under MC
Used to value
inventory
under AC
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Lecture5
Cost Assignment
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Service Centre Cost Allocation:
Overview Businesses: determine total cost of making a
product for Profitability analysis
Selling price determination
Inventory valuation purposes
Cost card: Cost/Unit
Direct materials 4kg@2/kg 8
Direct labour 3 hours @ 7/hr 21
Direct expenses 4
Prime costs 33
Indirect costs (overheads) 10
Total cost4
3
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Production Overheads Overhead
Costs incurred in the course of production that
cantbe traced directly to the product or service. Overheads can be broken down into:
Indirect materials e.g. Oil, grease, paper towels
Indirect labour supervisors salary, CEO salary
Indirect expenses rent, rates, insurance,depreciation
Prime costs easy to determine and allocate
Overheads can be difficult!
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Steps Step 1
Allocation and apportionment of production
overheads to cost centres
Step 2
Reapportion service cost centre overheads
Step 3 Absorption of overheads into production
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Step 1 - ExampleAllocation and apportionment of production overheads to cost centres
Overhead allocation and apportionment
Mars Ltd has the following overheads in the year ended 31 December 20x5
Overheads:
Rent and rates 90,000
Insurance of machinery and equipment 40,000
Stores costs (wages and salaries) 75,000
Heating costs 57,000
262,000
Additional information:
Mixing Stirring Stores Canteen Total
Floor space (square ft) 9,000 3,000 1,000 2,000 15,000
NBV of machinery and equip. 2,000 1,000 600 400 4,000
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Step 2 (cont.) Service centre cost apportionment
Two methods:
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Step 2 (cont.) Direct Method: (simple but inaccurate)
All inter-service department work is ignored
Overheads reapportioned directly to production
cost centres Mainly used when:
Only one service centre, or
Service centres do not work for each other
The Reciprocal Method (repeat distribution) Recognises all inter-service department work
Carried out in two ways: Repeat distribution/continuous apportionment, or
Algebraic method
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Step 3 Absorption of
overheads into production
All production overheads now apportioned
Need to charge to COST UNITSpassingthrough process
i.e. Termed Absorption
OAR: Production overhead
Activity levelOAR =
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Activity Based Costing (ABC) Modern alternative to Absorption Costing (AC)
Traditional Absorption Costing (AC) Uses a single basis forabsorbing overheads into cost
units Companies choose best/most appropriate basis for
absorption
X
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ABC (cont.) Is an extension of AC
Considers what causes each type of
overhead (i.e. what the cost drivers are) Steps in ABC
Step 1: Group overheads into activities
Step 2: Identify cost drivers for each activity Step 3: Calculate cost per unit of cost driver
Step 4: Absorb activity costs into production
Based on usage of cost drivers
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Lecture 6
Measuring RelevantCosts and Revenues for
Decision Making
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Relevant Costs A future cashflow arising as a direct
consequence of a decision.
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Relevant Input Costs - Materials
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Relevant Input Costs - Labour
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Relevant Input Costs - Overheads In general:
Variable costs will be relevant costs
Fixed costs will be irrelevant to a decision
Note: there may be times when FCs are
relevant
General fixed overheads - not relevant! Often apportioned share of fixed costs
i.e. Unaffected by decision
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Short-term Decisions Based on
Relevant Costs1) Make or Buy?
Maximum price to outsource
Ignore sunk/unavoidable costs
2) Shutdown decisions Decisions involve the closure of divisions/products
(Adding/Dropping Segments)
Appear to be loss-making
Focus on relevant costs (and revenues) IFtheclosure is made, i.e. impact on whole organisation
3) Special Orders
Minimum price for one-off decisions
Its total relevant costs (price breaks even)
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Lecture 7
Capital InvestmentDecisions
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Investment Decision Making Decisions of a long-term nature Form part of the capital budget
Proposals generated by:
Environmental scanning In response to an identified problem
Evaluation techniques (or combination)a) Payback period
b) Accounting rate of return
c) Net present valued) Discounted payback
e) Internal Rate of Return
f) Modified Internal Rate of Return
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Capital Rationing - Summary
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Taxation and Investment Decisions Taxation legislation specifies that net cash
inflows of companies are subject to taxation,
and capitalallowances (writing downallowances) are available on capital
expenditure.
STEP 1 Calculate capital allowances
STEP 2 Calculate incremental taxes arisingfrom the project
STEP 3 Tax effect of balancing allowance
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Lecture 8
Budgeting
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Budgets Part of the overall process of planning and control
Budgets: assist in achieving objectives
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Budget PreparationSales Budget
(units, s)
Production
Budget(units)
Overheads
Budget(units, s)
Labour
Budget(hrs, s)
Materials Usage
Budget
(kgs, litres, etc)
Materials Usage
Budget
(kgs, litres, etc)
Operating budgets:
Budgeted Financial Statements
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Alternative Budget Systems
Fixed vs. Flexible Budgets
Incremental Budgeting vs. Zero-base Budgeting
Rolling budgets (Continuousbudgets)
Activity-based Budgeting
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Behavioural Aspects Participation in budgeting
In a top-down system, budgets imposed onindividuals by managers
In bottom-up system, budget holder invited tohave input at the budget setting stage
Advantages of top-down (imposed)
systems
Advantages of bottom-up budgeting
systems
Likely to be quicker More detailed local information used in
budget setting process
Avoid budgetary slack and budget bias Morale and motivation is improved
Utilise senior management awareness of total
resource availability
Increased likelihood of achievement
Avoids taking local management away from
day-to-day duties
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Beyond Budgeting Recently criticisms levelled at tradition budgeting:a) Time consuming and adds little value
b) Insufficient external focus
c) Too rigid and prevents rapid response
d) Protects rather than reduces costse) Stifles innovation
Beyond budgeting: 2 underlying concepts
i) Adaptive management processes ii) Decentralised management
Planning on a rolling basis Mangers empowered to make decisions (speeds upresponse times and exploits opportunities)
Focus on cash forecasts not cost control Responsibility drives motivation. Rewards are team
based
KPIs referenced to external benchmarks
such as competitors
Customer-orientated teams are established
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Lecture 9&10
Standard Costing andVariance Analysis
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Standards A standard
Represents what should happen than what has
happened
Prepared by management in advance Details expectations of the future
Standard cost is a predetermined estimated
unit cost
Calculated using expectations of:
a) Efficiencylevelsin the use of materials and labour
b) Expectedprice of materials, labour and expenses
c) Budgetedoverheadcosts and activity levels
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Uses of Standard Costs Two principal uses
Value inventory and cost production (MC &AC)
Acts as a control device (variance analysis) i.e. Difference between standard & actual results
Advantages of setting standards Disadvantages of setting standards
a) Facilitates budgetary control a) Difficult to forecast accurately
b) Leads to more accurate budgeting b) Time consumingc) Assists performance measurement c) Regular revisions required
d) Assist in target setting for staff d) Demotivating if wrong
e) Assists in price setting
f) Simplifies bookkeeping
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Variances Explain the difference between actual results
and expected results and provides
information for performance evaluation andcontrol purposes. i.e. Standard costs and revenues
Variances can be divided into three main
groups: i) Variable cost variances
ii) Fixed overhead variances
iii) Sales variances
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A General Model
for Variance Analysis
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity
Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard Quantity
Actual Price Standard Price Standard Price
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Material Variances: Price and Usage
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Labour: Rate, Idle Time & Efficiency
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Labour: Rate, Idle Time &
Efficiency
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Variable Overhead Variances:Expenditure & Efficiency variance
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Fixed overheads Variances
under MC and AC Marginal Costing:
Absorption Costing:
Fixed overhead expenditure variance
= Budgeted fixed overhead Actual fixed overhead
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Sales Variances: Price and Volume
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Budgeted net profit xxx
Sales variances
Sales margin price xxx
Sales margin volume xxx xxx
Direct cost varianceMaterial Price: xxx
Usage: xxx
Labour Rate xxx
Efficiency xxx
Manufacturing overhead variancesVariable overhead Expenditure xxx
Efficiency xxx
Fixed overhead expenditure xxx xxx
Actual profit xxx
Operating Statements
(Standard Marginal/Variable Costing System)
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Budgeted net profit xxx
Sales variances
Sales margin price xxx
Sales margin volume xxx xxx
Direct cost varianceMaterial Price: xxx
Usage: xxx
Labour Rate xxx
Efficiency xxx
Manufacturing overhead variancesVariable overhead Expenditure xxx
Efficiency xxx
Fixed overhead Expenditure xxx
Volume xxx xxx
Actual profit xxx
Operating Statements
(Standard Absorption Costing System)
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Interpretation of Variances Care taken when interpreting variances
Operational causes of variances (See pdf
file)
Interdependence of variances:
Identified for effective interpretation
When two variances are interdependent; One usually adverse
The other favourable
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Interdependence of Variables Eg:
Variance analysis Consider overall consequence
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Revisiony Exam paper 2010/2011
y Lecture slides (and other materials)/ seminar questions
y Use self-assessment questions as additional revision exercises (solutions at the back of
Drury 7th).
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Exam
Date: 27 January
Time: 16h30
Venue: ?
Format: Choose 4 from 5 (4*25 marks) No lecture on Jan 9th (Revision Week),
instead, email me ([email protected]) in
advance for a clinic slot between 13:00
17:00, Jan 11th, Wednesday. Note that the group project mark will be
released via email during the revision week.